VALUE JUDGEMENT

Has the FCA missed the mark in its attempts to protect customer value for money in insurance products?

The FCA has become increasingly concerned with protecting customer ‘value for money’ in the insurance industry. How has this focus been manifested by the regulator and what are the key challenges for insurers?

As we noted in the 2020 edition of Emerging Themes in Financial Regulation , in recent years the FCA has been increasingly interested in ensuring fair pricing for financial products.

This area of focus now appears to be morphing into a more general concern with ensuring that retail customers obtain value for money from their financial products as discussed during our Emerging Themes webinar on 28 January 2021 focusing on emerging themes for the insurance sector.

We saw this concern manifest most clearly in the retail insurance sector last year, following publication in November 2019 of the FCA’s finalised guidance on value in the distribution chain, FG 19/5.6 The most important aspect of this new guidance was the FCA’s position that, even if an insurer had done its ‘product governance’ homework thoroughly (in terms of ensuring it was designing a product to the identified needs of a specified target market), there was still a real risk of an insurance product not delivering fair value to its consumers. The guidance explained that this could happen if the number or nature of distributors in the distribution chain meant that customer value leaked out of the product due to excessive distribution costs:

“While the product may provide benefits to the customer, the level of distributors’ remuneration may mean the product fails to provide the intended value identified in the product approval process.”. The FCA’s guidance declined to clarify, however, at what specific level or percentage a distributor’s commission would become excessive.

This focus by the FCA on how much, in real terms, insurers were paying to their distributors is a new development. The idea that insurers needed to be able to justify the level of remuneration they are paying their distributors by reference to the cost to the distributors of providing their distribution services is particularly new and problematic in the context of the commercial realities of the sector. Further, the lack of clear guidance from the FCA as to what level of remuneration it would consider acceptable has meant that renegotiating contracts with distribution partners to ensure that they are within the “acceptable” range was (and remains) highly challenging for insurers.

The FCA’s position on regulating value for money in insurance… is fundamentally unworkable.

Unfortunately, we are now in a place where the FCA’s position on regulating value for money in insurance, while starting from a proposition that is uncontroversial (i.e. that consumers should not pay a disproportionate level of hidden commission for their insurance products, because that erodes their value for money), is fundamentally unworkable. This is because it does not take into account the dynamics of the insurance distribution chain. Insurers do not drive commission levels; insurance distributors do. For as long as the FCA declines to provide clear rules (or even clear guidance) on what is the acceptable level of remuneration to be paid to distributors of general insurers, there will be little that insurers themselves can do to ensure that they are able to meet the FCA’s demands (and indeed their obligations under the Insurance Distribution Directive, and specifically the ‘customers’ best interests rule’) to treat their customers fairly in this area.

EIOPA was less coy than the FCA had been about putting a figure on the level of commission that should be deemed inappropriate.

Notably, we have also seen the European Insurance and Occupational Pensions Authority (EIOPA) follow the FCA’s lead by publishing its own thematic review report on insurance value for money in late 2019, focussing specifically upon retail customers of travel insurance.7 EIOPA was less coy than the FCA had been about putting a figure on the level of commission that should be deemed inappropriate, stating that “While the average commissions in travel insurance are around 24% of the gross written premium (GWP), there are insurers that pay extremely high commissions to distributors, of significantly more than 50% of the premium”. By naming the level above which commission is said to become “extremely high”, EIOPA’s thematic review report is more useful to insurers looking for an external reference point to guide them when renegotiating their distribution contracts in view of the FCA’s thematic review report. Interest in protecting value for money by other European regulators will surely follow: we understand that the Italian regulator, CONSOB, is already gathering evidence to support its own work in this area. It may be that other regulators have a different view than the FCA and decide to take a more prescriptive approach to the level of remuneration that is acceptable within a distribution chain.

1 https://www.fca.org.uk/publication/finalised-guidance/fg19-05.pdf

2 https://www.eiopa.europa.eu/content/consumer-protection-issues-travel-insurance_en

CONCLUSION

The COVID-19 pandemic has brought about an even clearer FCA focus on value for money for policyholders, with insurers currently being required by the FCA to re-assess the value that their products offer to consumers in light of the new living and working conditions brought about by the pandemic. Indeed, insurers are even encouraged by the regulator to consider premium rebates where appropriate. (Interestingly, the PRA takes a slightly different view on this, warning insurers not to offer COVID-19-related rebates unless they are sure that they have the financial resources to do so – an insight into the sometimes conflicting regulatory priorities of the PRA and FCA.)

The COVID-19 pandemic has brought about an even clearer focus by the FCA on value for money for insurance customers.

While the FCA’s concern in this area is not misplaced, its execution strategy is misguided. To tackle the thorny issue of value-for-money leakage in retail insurance as a result of inflated commissions, something more pointed than a guidance paper is needed. In the meantime, FCA-regulated insurers will be trying their best to comply with the spirit of the FCA’s finalised guidance in FG 19/5 (in the absence of any prescriptive rules or guidance on what an acceptable level of remuneration would be). They can achieve this by carrying out their own assessments of the benefits to consumers of the services being provided by their distributors, and whether these are sufficient to justify the level of remuneration being paid.


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POLLY JAMES

Partner, London

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SIÂN COWAN

Associate, London

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This document provides a general summary and is for information/educational purposes only. It is not intended to be comprehensive, nor does it constitute legal advice. Specific legal advice should always be sought before taking or refraining from taking any action.

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